Up to 20 councils across the country stand to lose tens of millions of pounds after the government refused to guarantee wholesale deposits which were deemed worthless after the collapse of Icelandic banks.

The Local Government Association (LGA) has written to Alistair Darling to ask for councils to be treated in the same way as individual savers who were given a government guarantee yesterday that they would be compensated.

The chancellor said local authorities could not expect to receive the same treatment as individual Britons who are holders of more than 300,000 retail accounts in Icelandic banks. "They're a more informed investor," he told MPs.

Treasury sources indicated last night that he would consider representations from council leaders. "The chancellor will give them a sympathetic hearing," one government source said.

However, it emerged last night that UK savers will be lucky to get their money by Christmas. After spending the day trying to mount a package to return their money earlier, the Financial Services Authority said the Icelandic internet bank Icesave was technically in "default" - thereby triggering payouts by the official but slower financial services compensation scheme (FSCS).

The prospect of a lifeline for the local authorities was floated after the LGA warned more than 20 councils had deposits with one of Iceland's largest banks, Landsbanki, taken into Icelandic government control on Tuesday.

Kent county council has £50m in Landsbanki and its UK subsidiary Heritable, as well as Glitnir Bank, while Westminster city council has £17m in Icelandic accounts.

The LGA's intervention came after the chancellor announced that no UK saver would lose money from the closure of Icesave. About £4bn of Britons' money was in its accounts when it ceased trading after its parent, Landsbanki, went into receivership on Tuesday.

In a separate move, the Treasury yesterday arranged for more than £3bn of UK savers' money in other Icelandic banks to be transferred to UK arm of the Dutch savings bank ING Direct. About 160,000 customers of Kaupthing Edge and savers with Heritable have become ING customers after the Treasury used its emergency powers to move their savings.

The Treasury said it had frozen all Landsbanki's UK assets and would seek to recoup losses from the Icelandic government - in the courts if necessary. Under the terms of the rescue package, Iceland was responsible for the first £16,000 of each saver's claim for compensation.

The announcement that there will be compensation ended an anxious 36 hours for Icesave customers. Many feared they would lose any savings over £50,000 - and possibly more, had Iceland refused to meet compensation obligations.

FSCS chief executive Loretta Minghella said: "Following the chancellor's announcement today, people can be confident they will be repaid in full."

Exposed to losses

Kent county council £50m

Brent approx £15m

Westminster £17m

West Sussex county council £12.9m

Havering £12.5m

Sutton £5.5m

Ipswich £2m

· This article was amended on Friday October 24 2008. In a sub-headed section of the article above we misstated the potential extent of Brent council's losses due to the collapse of Icesave. Brent's potential losses were approximately £15m, not £27m as we said. This has been corrected.